Case Study: Mahony v. East Holyford Mining Co.

CITATION: (1875) LR 7 HL 869

DATE OF JUDGMENT: June, 1875

BENCH: Lord Chief Baron Kelly, Blackburn (J), Mellor (J), Brett (J), Grove (J), and Baron Pollock (J)

“When there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, those so dealing with them externally are not to be affected by irregularities which may take place in the internal management of the company.”^[1]

FACTS

• The National Bank, acting in good faith, entered into financial transactions with the East Holyford Mining Company based on the authorization of the company’s directors.
• The Articles of the company provided that the cheque shall be signed by two directors and countersigned by the secretary. It later came to light that neither the directors nor the secretary who signed the cheque was appointed properly.
• The directors and the secretary lacked the proper internal authorization from the company itself to secure these loans.
•  The bank proceeded to cash the checks signed by Wadge, the purported secretary, without verifying the legitimacy of the directors’ signatures or confirming Wadge’s authority to act as secretary.
• With the company facing bankruptcy, the bank seeks to invoke the Turquand Rule as a means to evade accountability for the funds disbursed.

The House of Lords’ Verdict:

In a pivotal decision, the House of Lords sided with the National Bank, establishing the principle of apparent authority^[2]. This principle safeguards external parties who interact with a company in good faith. Even if there are internal irregularities in the appointment or actions of a company’s officers, third parties can rely on the outward appearance of authority. The court’s reasoning focused on protecting outsiders who would not have a reason to suspect any issues within the company’s internal management structure.

ISSUES

• Should the bank be held responsible for the internal governance failures within the East Holyford Mining Company?
• Is an outsider expected to have knowledge of the validity of the appointment of directors and secretary?

KEY POINTS DISCUSSED IN THE CASE

• Should the bank be held responsible for the internal governance failures within the East Holyford Mining Company?

NO

Lord Wensleydale in Ernest v. Nicholls[3] had distinctly and expressly declared that it was the duty of persons dealing with directors to make themselves acquainted with the deed of association and the provisions of the statute, and if they did not choose to do so, but gave credit to “any unauthorized persons, they must be contented to look to them only and not to the company at large.” Vice-Chancellor Wood in Re The Athenœum Life Insurance Society[4] adopted and enforced that principle. The bankers here not having taken any trouble on the matter, they had paid away the money to persons not entitled to receive it, and so made themselves liable to bear the loss. It is admitted that if persons were appointed as directors, and appeared to act as such, but it was afterwards discovered that their appointment had only been irregularly made, those who bona fide dealt with them in that character would be protected, but that could not affect a case where there had been no appointment at all.

But, in this case, the bank cannot be held responsible for the internal governance failures within the company because of the principle of apparent authority. The concept of apparent authority functions as a safeguard for external parties who interact with a company in good faith. This doctrine protects individuals who conduct business with a company representative who gives the impression of having the power to act on the company’s behalf. This protection extends even to situations where the representative may not possess actual, explicitly granted authority. The principle essentially prevents a company from denying an agent’s authority after an external party, acting reasonably, has relied upon that agent’s apparent power. This serves to uphold fairness and prevents external parties from being misled in their dealings with a company.

• Is an outsider expected to have knowledge of the validity of the appointment of directors and secretary?

NO

In the case of Royal British Bank v. Turquand[5], it was held, when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, then those so dealing with them, externally, are not to be affected by any irregularities which may take place in the internal management of the company. They are entitled to presume that that of which only they can have knowledge, namely, the external acts, are rightly done, when those external acts purport to be performed in the mode in which they ought to be performed.

The House of Lords upheld the doctrine of indoor management, and cited, the bank is neither required nor expected to have knowledge relating to the validity of the appointment of the directors and secretary of the company that they are dealing with. The question of appointment of director comes under the preview of internal management of the company and the third party who receives the cheque is entitled to presume that the directors had been properly appointed.

JUDGMENT

The House of Lords held that the bank was not required to enquire about the appointment procedure and of its fulfilment. It was held that the bank’s obligation was limited to reviewing the memorandum of association and the articles of association. Upon doing so, the bank would have discovered the specified procedure for appointing directors. From this information, the bank could reasonably have inferred that the directors had indeed been properly appointed. The Bank, however, cannot be expected to verify whether the due procedure has been followed or not.

^[1] William Page Wood, 1st Baron Hatherley

^[2] a company can be bound by an agent’s actions, even if the agent was not actually authorized, so long as a reasonable person would believe they had the power to act.

[3] 6 H. L. Cas. at p. 419.

[4] 4 K. & J. 549; 27 L. J. (Ch.) 125. 829.

[5] 6 EL. BL. 327.